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NKE: Our Answer to ASP Debate

Takeaway: We understand why people want proof that $NKE can deliver on ASP growth before getting bullish. But waiting for proof will be too late.

One point of pushback we got on the road recently about our Long NKE call is that the company will be unable to cycle its price increases in footwear. We think the argument is moot for several reasons.

  1. You could have made this argument in 2011. Then again in 2012. You’d have been wrong. In making in 2013 we think you’ll be wrong again.
  2. In 2H11 it appeared as if the sky was falling as you can see in the chart below, and ASPs were on their way back down from consistent mid-single digit gains. That ended up being very wrong as the company launched products like FlyKnit and Nike+ They manage the business for either units or asp – rarely if ever do they happen simultaneously.
  3. ASP does not only mean price.  While Nike has certain evergreen product like Dunks and certain Bowerman running product in this business it is near impossible to put through price increases on like for like product. That’s in part because like for like product does not exist. 90% of the product line changes every 90 days. But overwhelmingly, we’re talking mix, not price. And most importantly, higher mix does not mean higher profitability. In fact, while ASP went up over the past two years, Gross Margin in aggregate went down. This was in large part due to apparel, but the so-called ‘strength’ in footwear profitability should have otherwise offset apparel weakness. It did not.
  4. The punchline is that there needs to be an element of trust here. We hate saying that, as trust is hardly an investment process. But the company manages its business around a top line number. There are times when it fuels this top line goal by higher average prices due to a new product launch at a high price (but at lower volumes), and then there are other times where the product works its way into ‘proliferation mode’ to a lower-price-point consumer and greatly accelerates unit growth in more mainstream channels of distribution (ie Kohl’s instead of Nike Retail). There are not many companies where we’ll front them any form of success in their business plan, but the fact is that Nike has an overwhelmingly successful track record in delivering on its expectations for managing the product price/volume curve (notably in footwear). We won't blindly trust that they hit their goal, but we'll give them the benefit of the doubt.


We understand why people want proof of the company’s ability to deliver on the top line before they get bullish. But in this instance, and at this price, we think that waiting for proof will simply be too late.    


NKE: Our Answer to ASP Debate - 11 30 2012 12 39 19 PM


Takeaway: $NKE is our top idea in Retail, and now both quantitative and qualitative factors are converging to the upside.

We think that price and fundamentals are positively converging for Nike on both a quantitative and qualitative basis. We like the name on both a TRADE, TREND and TAIL basis, and added it to the Hedgeye Virtual Portfolio accordingly. Here’s our rationale…



TAIL: Nike’s growth algorithm over the next three year time period based on our model is unmatched. With a revenue CAGR of 10% leveraging to EBIT growth of 15%, EPS of 19%, and Free Cash Flow over 30%, it’s tough not to be impressed. Considering that this formula belongs to what is likely one of the top 10 brand names in the world, and the leader of a duopoly in a GDP plus industry (sports apparel) with a bullet proof balance sheet, it is tough to not be impressed. If we’re right, the Street is underestimating earnings by 10% over this time period. That’s enough for us to get excited about the name here – even at a seemingly lofty multiple.






TREND: We think that gross margins -- the biggest factor impacting NKE’s sentiment and performance – will turn up meaningfully over the next three quarters. As the chart below shows, Futures has always seemingly been the biggest stock driver.




But it’s clear that something has taken over in the past six quarters, and it is clear to us – both quantitatively and anecdotally based on discussions with big institutions – that this is Gross Margin. Others might argue that it is China, or the sustainability of the ‘sneaker cycle’. We see the logic, but don’t agree with it. Our strong view is that once Gross Margins turn, then the stock will follow.  




Inventories have already started to move in the right direction, and we think that they’re cleaner today than they’ve been in two years. The relationship between inventories and margins is abundantly clear. FX also plays a big role, and at the current rate we’ll be back to yy parity within 2 months’ time.


Ultimately, the real delta to watch is ‘Futures less Inventories’ vs Gross Margins.  That accounts for demand (Futures) as well as the company’s ability to manage those orders in the form of inventory. That’s something that we’ve started to see turn, and we expect to increasingly move to the upper right as soon as 2Q which is reported in 3 weeks.




TRADE: The company reports the quarter in late December. We think that the 2-quarter streak of EPS growth rolling over will finally come to an end, and the consensus expectation for a flat quarter will be proved wrong. We think that expectations for Europe, China and even Emerging Markets remain very grounded. We’re at $1.06 versus the Street at $1.00, and we think that the company will be bullish about its look into calendar 2013.


VALUATION: The stock is trading at about 17x NTM earnings, well ahead of the 13x market multiple. That might seem unreasonable, but a) the stock is closer to 15.5x our numbers, and b) the market does not have the same characteristics as Nike with a path for a 10% sales CAGR leveraging to 30%+ Free Cash Flow.



YUM: Built To Last

Yum! Brands (YUM) is selling off strong today after worse-than-expected preannounced China comps spooked analysts and investors last night.  Several downgrades from the Street today have added to the fear, creating what we have seen time and again in this stock: the China scare buying opportunity. 


YUM is geographically diverse from an operating income perspective  (first chart, below) but not so much from a sentiment perspective.  The perception among many investors is that this is a “China stock”.  While China is important for YUM, we would highlight that previous sequential decelerations in China’s Real GDP Growth and YUM’s China comps have not resulted in corresponding deceleration in earnings growth (second chart, below).  EPS growth has been remarkably consistent over the past number of years with economic growth rates in China and other markets varying over time.


YUM: Built To Last - YUM1


With today’s sell off, a spate of downgrades, and what seems to be a full baking in of worse China growth expectations, we believe that YUM represents a very attractive opportunity on the long side. 


YUM: Built To Last - YUM2

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Energy and Volatility

We’ve already discussed the importance of the CBOE Volatility Index (VIX) hitting 14 and how it affects stocks, but what about other markets like energy? With volume and volatility moving lower, risk increases. Energy is a high beta sector, meaning that when the broader market sells off, energy sells off further and faster (and vice versa). The Energy Select SPDR ETF (XLE) is heading lower and when the VIX hits 14, it’ll likely take a beating.


Energy and Volatility - xle vix

Watching The VIX


Hedgeye CEO Keith McCullough appeared on CNBC’s Fast Money earlier this week and discussed the markets and America’s debt ceiling issues. One topic that’s more important than ever today is volatility in the market. The CBOE Volatility Index (VIX) is the de facto measurement of market volatility and when the index is at 14 (it’s currently at 15), it becomes a clear indicator to sell stocks. Keith calls it one of the most “obvious, clean-cut sell signals” out there. We short the S&P 500 when the VIX hits the low 14s and will continue to do so when the VIX hits those levels.


Watch Keith's full take on the VIX and when to sell stocks in the video posted above.


Mo' Money, Mo' Problems

Client Talking Points

The Vix

Not to be confused with the ‘80s band The Fixx, the CBOE Volatility Index (VIX) is at 15 and fast approaching the key level of 14. When the VIX is at 14, it’s a clear level to sell stocks for us and the rest of the institutional crowd out there. As we head into the weekend, keep an eye in the index in today’s trading. Provided there are no blowout catalysts in today’s market, volatility should remain at current levels.

Turning Japanese

With politicians debating what to do about the Fiscal Cliff on a daily basis and less than a month left until we hit the debt ceiling, things aren’t looking cheery for the United states right now. We’re beginning to look like Japan in ways as population growth slows along with our GDP numbers. The Federal Reserve’s agenda of printing money to solve problems hasn’t fixed anything and has artificially inflated commodity prices and the stock market while devaluing our currency over the years. With the US dollar down two weeks in a row, dollar bulls can’t call the currency the Comeback Kid just yet.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

After a long downward slide, TCB has finally turned the corner. The margin has stabilized after the balance sheet restructuring. Loans are growing thanks to the equipment finance business. Non-interest income is more likely to go up than down going forward, a reversal from the past 18 months. Credit quality has a tailwind from a distressed housing recovery in TCB’s core markets: Minneapolis, Detroit and Chicago. On top of this, the CEO, Bill Cooper, is one of the oldest regional bank CEOs, which raises the probability that the bank will be sold. Expectations are bombed out at this point, so we think it’s time to move from bearish to bullish on TCB.


There is improving visibility on 20%+ EPS growth with P/E of only 11x with better content leading to market share gains. New orders from Canada and IL should be a catalyst. Additionally, many people in the investment community are out in Las Vegas at the annual slot show (G2E) and should hear upbeat presentations by management.


While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road


“I wish one politician would call it what it is..taxes, not revenues” -@upsidetrader


“It is amazing what you can accomplish if you do not care who gets the credit.” -Harry Truman


Unemployment in the Eurozone hit a new high of 11.7% in October.

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